Monday, March 15, 2010

Plan To Be Followed When You Walk Away From Debt

As the economy continues to weaken, the number of individuals and businesses deciding to “walk away” or strategically default from debt continues to grow. Lenders have taken notice. Lenders are taking a long term outlook when it comes to collecting debt. Bottom Line: Lenders understand that a debtor who is unable to pay now may be able to pay later. In the case of a strategic default, where a debtor intentionally stops paying even though they possess the ability to continue paying a lender is keenly aware that it can most likely collect in the future. Lenders are developing classifications for debtors to determine the likelihood of collecting from that debtor in the future.It's important to understand that a lender has several options when a debtor walks away or strategically defaults from debt.

That said, let’s review the various options a lender has at its disposal to collect unpaid debt. This article is divided into two sections. The first section generally discusses the two main options available to a lender to collect a debt. The second section contains links to various national online news sources with stories about everyday people deciding to strategically default and walk away from debt and the ensuing consequences.

Lenders Have Two Main Options to Deal With Unpaid Debt:

1. A lender can obtain a judgment for the entire amount of the unpaid debt or a deficiency judgment on the difference between what it is owed and what it collects. For example, if a lender is owed $250,000 but collects $100,000 the $150,000 difference is considered a deficiency debt. The lender can make an application with a court to turn the deficiency debt into a deficiency judgment. If a lender gets a deficiency judgment, the lender can garnish wages, place a lien on a bank account, or place a lien on personal, business, and real estate assets. In some states a deficiency judgment can stay valid for as long as 20 years. A lender may sell the deficiency to a third party debt collector.

2. A lender can forgive the entire debt or forgive the difference between what it is owed and what they collect. In the same example described above a lender can forgive the $150,000 deficiency debt. If a lender decides to forgive the debt, it can file a 1099. Basically, forgiveness of debt is considered income by certain states and the IRS. In some cases, forgiven debt will not be considered income, if a debtor meets certain requirements.

"Lenders are hiring collection agencies. They also are getting deficiency judgments -- court orders that allow banks to collect on mortgage balances. Once an order is in place, lenders can garnish wages, tap bank accounts, seize tax refunds and put liens on other assets to satisfy the debt. These judgments also show up on credit reports."

"People are walking away from their mortgages by the thousands, making a financial decision that it's better to take the hit on their credit score than try to recover $300,000 of negative equity on a $600,000 home purchased at the peak of the housing bubble. They're called "strategic defaults."

"As a recourse state, Nevada leaves the door open for lenders and collection agencies to pursue homeowners with deficiency judgments, going after assets and income years after a foreclosure or short sale, or bank-approved sale for less than the mortgage owed."

"Homeowners who feel relieved to have the burden of debt lifted may be surprised to receive a letter from a collection agency two or three years down the road demanding payment on their old mortgage."

"But borrowers have to weigh several practical considerations of so-called strategic default. They risk being sued by the lender for the unpaid mortgage balance for up to 20 years. Their credit will take a huge hit, making it difficult to get a credit card or a car loan. And the poor credit rating could affect future employment and mean higher auto insurance rates...'Those who walk away and let their homes fall into foreclosure can expect to see their credit scores drop...Foreclosures stay on borrowers’ records for 10 years, and they won’t be able to get other mortgages for at least two or three years...There may be tax issues, too. If lenders forgive the mortgage debt, borrowers who walk away from investment properties risk having to pay federal income taxes on the forgiven amount. Forgiven mortgage debt through 2012 is not taxable income on a primary residence as long as the debt was used to buy or improve the house."